Fair Value Disclosures

9 Months Ended

Sep. 30, 2020

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 15 of the Company’s 2019 Form 10-K, except for the valuation of derivative financial instruments, the indemnification asset recognized in connection with the factored receivables acquired from TFS, and Paycheck Protection Program Liquidity Fund borrowings, which the Company entered into in during the three months ended June 30, 2020.

Derivative Financial Instruments

Currently, the Company uses interest rate swaps as part of its cash flow strategy to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash

flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The derivative financial instrument fair value is considered a Level 2 classification.

Indemnification Asset

The fair value of the indemnification asset is calculated as the present value of the estimated cash payments expected to be received from Covenant for probable losses on the covered Over-Formula Advance Portfolio. The cash flows are discounted at a rate to reflect the uncertainty of the timing and receipt of the payments from Covenant. This discount rate was 4% at September 30, 2020. The indemnification asset, which is included in other assets in the Consolidated Balance Sheets, is reviewed quarterly and changes to the asset are recorded as adjustments to other noninterest income or expense, as appropriate, within the Consolidated Statements of Income. The Company's estimate of probable losses on the covered portfolio did not change between the acquisition date and September 30, 2020 and therefore, no activity related to the indemnification asset was recorded during the three and nine months ended September 30, 2020. The indemnification asset fair value is considered a Level 3 classification.

Paycheck Protection Program Liquidity Fund

The Company’s PPPLF borrowings correspond to PPP loans and are expected to be short term in duration, therefore fair value materially approximates carrying value and is considered a Level 2 classification.

Assets and liabilities measured at fair value on a recurring basis are summarized in the table below.


(Dollars in thousands)	Fair Value Measurements Using								Total Fair Value
September 30, 2020	Level 1		Level 2		Level 3
Assets measured at fair value on a recurring basis
Securities available for sale
U.S. Government agency obligations	$	—	$	18,448	$	—	$	18,448
Mortgage-backed securities, residential	—		29,790		—		29,790
Asset-backed securities	—		7,091		—		7,091
State and municipal	—		43,362		—		43,362
CLO securities	—		117,491		—		117,491
Corporate bonds	—		22,927		—		22,927
SBA pooled securities	—		3,693		—		3,693
	$	—	$	242,802	$	—	$	242,802

Equity securities
Mutual fund	$	6,040	$	—	$	—	$	6,040

Loans held for sale	$	—	$	36,716	$	—	$	36,716

Derivative financial instruments (cash flow hedges)
Interest rate swap	$	—	$	16	$	—	$	16

Liabilities measured at fair value on a recurring basis
ICC Contingent consideration	$	—	$	—	$	21,991	$	21,991


(Dollars in thousands)	Fair Value Measurements Using								Total Fair Value
December 31, 2019	Level 1		Level 2		Level 3
Assets measured at fair value on a recurring basis
Securities available for sale
U.S. Government agency obligations	$	—	$	39,760	$	—	$	39,760
Mortgage-backed securities, residential	—		38,016		—		38,016
Asset-backed securities	—		7,959		—		7,959
State and municipal	—		32,065		—		32,065
CLO Securities	—		75,273		—		75,273
Corporate bonds	—		51,583		—		51,583
SBA pooled securities	—		4,164		—		4,164
	$	—	$	248,820	$	—	$	248,820

Equity securities
Mutual fund	$	5,437	$	—	$	—	$	5,437

Loans held for sale	$	—	$	2,735	$	—	$	2,735

Liabilities measured at fair value on a recurring basis
ICC Contingent consideration	$	—	$	—	$	21,622	$	21,622

There were no transfers between levels during 2020 or 2019.

On June 2, 2018, the Company acquired substantially all of the operating assets of, and assumed certain liabilities associated with, Interstate Capital Corporation’s (“ICC”) accounts receivable factoring business and other related financial services. Consideration for the acquisition included contingent consideration, which is based on a proprietary index designed to approximate the rise and fall of transportation invoice prices subsequent to acquisition. The index is calculated by a third party data analytics firm and is correlated to monthly movements in average invoice prices historically experienced by ICC. At the end of a 30 month earnout period after closing, a final average index price will be calculated and the contingent consideration will be settled in cash based on the final average index price, with a payout ranging from $0 to $22,000,000. The fair value of the contingent consideration is calculated each reporting period, and changes in the fair value of the contingent consideration are recorded in noninterest income in the consolidated statements of income. At September 30, 2020 and December 31, 2019, the ICC contingent consideration liability was the only recurring fair value measurement with Level 3 unobservable inputs. At September 30, 2020 and December 31, 2019, the fair value calculation of the contingent consideration resulted in a payout of $22,000,000, and discount rates of 0.2% and 1.7%, respectively, were applied to calculate the present value of the contingent consideration. A reconciliation of the opening balance to the closing balance of the fair value of the contingent consideration is as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2020		2019		2020		2019
Beginning balance	$	21,963	$	21,302	$	21,622	$	20,745
Contingent consideration recognized in business combination	—		—		—		—
Change in fair value of contingent consideration recognized in earnings	28		124		369		681
Consideration settlement payments	—		—		—		—
Ending balance	$	21,991	$	21,426	$	21,991	$	21,426

Assets measured at fair value on a non-recurring basis are summarized in the table below. There were no liabilities measured at fair value on a non-recurring basis at September 30, 2020 and December 31, 2019.


(Dollars in thousands)	Fair Value Measurements Using								Total Fair Value
September 30, 2020	Level 1		Level 2		Level 3
Collateral dependent loans
Commercial real estate	$	—	$	—	$	5,302	$	5,302
Construction, land development, land	—		—		637		637
1-4 family residential	—		—		5		5
Commercial	—		—		3,584		3,584
Factored receivables	—		—		33,803		33,803
Consumer	—		—		46		46
Other real estate owned ⁽¹⁾
1-4 family residential properties	—		—		189		189
	$	—	$	—	$	43,566	$	43,566


(Dollars in thousands)	Fair Value Measurements Using								Total Fair Value
December 31, 2019	Level 1		Level 2		Level 3
Impaired loans
Commercial real estate	$	—	$	—	$	534	$	534
Construction, land development, land	—		—		664		664
1-4 family residential	—		—		2		2
Commercial	—		—		4,754		4,754
Factored receivables	—		—		12,762		12,762
Consumer	—		—		8		8
PCI	—		—		67		67
Other real estate owned ⁽¹⁾
Commercial real estate	—		—		388		388
1-4 family residential	—		—		89		89
	$	—	$	—	$	19,268	$	19,268

⁽¹⁾Represents the fair value of OREO that was adjusted during the year to date period and subsequent to its initial classification as OREO.

Collateral Dependent Loans Specific Allocation of ACL: A loan is considered to be a collateral dependent loan when, based on current information and events, the Company expects repayment of the financial assets to be provided substantially through the operation or sale of the collateral and the Company has determined that the borrower is experiencing financial difficulty as of the measurement date. The ACL is measured by estimating the fair value of the loan based on the present value of expected cash flows, the market price of the loan, or the underlying fair value of the loan’s collateral. For real estate loans, fair value of the loan’s collateral is determined by third party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 5% to 8% of the appraised value. For non-real estate loans, fair value of the loan’s collateral may be determined using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business.

OREO: OREO is primarily comprised of real estate acquired in partial or full satisfaction of loans. OREO is recorded at its estimated fair value less estimated selling and closing costs at the date of transfer, with any excess of the related loan balance over the fair value less expected selling costs charged to the ACL. Subsequent changes in fair value are reported as adjustments to the carrying amount and are recorded against earnings. The Company outsources the valuation of OREO with material balances to third party appraisers. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction is based on the income and/or sales

comparable methods. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 5% to 8% of the appraised value.

The estimated fair values of the Company’s financial instruments not measured at fair value on a recurring or non-recurring basis at September 30, 2020 and December 31, 2019 were as follows:


(Dollars in thousands)	Carrying Amount		Fair Value Measurements Using											Total Fair Value
September 30, 2020					Level 1			Level 2			Level 3
Financial assets:
Cash and cash equivalents	$	288,278	$	288,278		$	—		$	—		$	288,278
Securities - held to maturity	6,096		—			—			5,473			5,473
Loans not previously presented, gross	4,810,731		197,859			—			4,593,233			4,791,092
FHLB and other restricted stock	18,464		N/A			N/A			N/A			N/A
Indemnification asset	31,218		—			—			31,218			31,218
Accrued interest receivable	20,254		20,254			—			—			20,254

Financial liabilities:
Deposits	4,248,101		—			4,254,371			—			4,254,371
Customer repurchase agreements	14,192		—			14,192			—			14,192
Federal Home Loan Bank advances	435,000		—			435,000			—			435,000
Paycheck Protection Program Liquidity Facility	223,713		—			223,713			—			223,713
Subordinated notes	87,455		—			89,806			—			89,806
Junior subordinated debentures	39,944		—			40,135			—			40,135
Accrued interest payable	6,006		6,006			—			—			6,006


(Dollars in thousands)	Carrying Amount		Fair Value Measurements Using											Total Fair Value
December 31, 2019					Level 1			Level 2			Level 3
Financial assets:
Cash and cash equivalents	$	197,880	$	197,880		$	—		$	—		$	197,880
Securities - held to maturity	8,417		—			—			6,907			6,907
Loans not previously presented, gross	4,170,604		83,454			—			4,086,597			4,170,051
FHLB and other restricted stock	19,860		N/A			N/A			N/A			N/A
Accrued interest receivable	20,322		20,322			—			—			20,322

Financial liabilities:
Deposits	3,789,906		—			3,793,603			—			3,793,603
Customer repurchase agreements	2,033		—			2,033			—			2,033
Federal Home Loan Bank advances	430,000		—			430,000			—			430,000
Subordinated notes	87,327		—			93,877			—			93,877
Junior subordinated debentures	39,566		—			40,700			—			40,700
Accrued interest payable	9,367		9,367			—			—			9,367

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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